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Do Public Subsidies Sell Green Cars?

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| December 2010

Evidence from the U.S. Cash for Clunkers Program

Introduction

Announced at a difficult time for consumers and automakers, the U.S. "Cash for Clunkers" program attracted significantly more attention than anticipated. The program offered up to a $4,500 rebate on the purchase of a fuel-efficient vehicle that would replace a gas-guzzler. Consumers rushed to auto showrooms across the country to take advantage of the program. Only days in to the program the projected payout exceeded the initial budget of $1 billion; and, despite another $2 billion pledged by U.S. Congress, the program used up the entire fund and had to conclude two months ahead of schedule. In the end, the program helped nearly 700,000 consumers exchange vehicles in only 55 days.

The efficacy of the program has been at the center of public interest. In particular, there is concern that consumers may have been taken advantage of the subsidies and purchased vehicles they would have bought anyway. In this case, the program itself could not take credit for reducing emissions because even without the program the fleet's fuel economy would still have improved. If it can be shown that vehicle demand cannot be manipulated by subsidies, policymakers should focus on alternative regulatory options such as setting more stringent fuel economy standards to green the fleet.

Thus, a central question in evaluating the program is whether it lured consumers to purchase greener vehicles than they otherwise would have purchased in the absence of the program. There are two possible methods to answer this question: conduct a survey or analyze actual purchases. As mentioned in the DOT Report to Congress (2009), the agency surveyed consumers when they applied for rebates, asking what they would have purchased in the absence of the program. Roughly 23 percent of respondents stated that they would have chosen larger, presumably less efficient, cars or trucks. While this was a response to a hypothetical survey, it seems to indicate that the program succeeded in selling fuel-efficient vehicles to people who had not planned to buy them.

This paper uses the second method, analyzing the actual transactions based on a special feature of the program: consumes had the opportunity to receive either $3,500 or $4,500 depending on how much they "improved" the fuel economy between their trade-in and a new vehicle. The higher rebate was granted only if the improvement reached a certain threshold (e.g. for a new car, running at least 10 more miles to the gallon than the trade-in vehicle). As a result, consumers trading in very inefficient vehicles could pick among most new vehicles to collect the rebate of $4,500, while consumers trading in more-efficient vehicles had to choose from a smaller pool of options or forgo the extra $1,000. Because of this variation in rebates among consumers, the program may be seen as a "natural" experiment revealing the relationship between subsidies and the subsequent vehicle selection by new car buyers.

Analysis results suggest that awarding $1,000 more for a given vehicle made 7.2% of consumers switch to that more-efficient vehicle or trade-in their less-efficient model. By extrapolating from this relationship, the program - granting an average of $4,200 per vehicle - may have made 25-30% of consumers change their vehicle selection; a range not far from the stated 23% in the DOT survey. Both methods suggest - consistently - that the program prompted a large number of consumers to buy the subsidized, more-efficient vehicles. Not only did the program stimulate economic activity, but it also benefited the environment by reducing emissions and fuel consumption. This finding should encourage policymakers to consider similar proposals, such as a feebate program that subsidizes fuel-efficient vehicles by taxing gas-guzzlers and distorting vehicle prices without incurring additional budget deficits (see Greene et al. 2005 for more discussion).

Scholars have found that subsidies can help expand a vehicle's market share. For example, see the work of Gallagher and Muehlegger (2008) and Beresteanu and Li (2009) on hybrid cars. These studies, however, often rely on subsidy variations between cities or states over a few years. During this period vehicle demand could have influenced, or have been influenced by, gasoline prices, vehicle supply, and decisions to grant subsidies. As a result, the causality between subsidies and vehicle selections indicated by the above studies may not be as established. This paper's analysis is based on the "Cash for Clunkers" program that was in effect for less than two months.

This paper builds on other studies investigating what factors affect vehicle selection at the consumer level (see Berry et al. 2004; Train and Winston 2007). In these studies, vehicle price is often a strong decision driver, and it is no surprise that the program's rebates, directly altering vehicle price, have also swayed consumer decisions. Nevertheless, this paper uses a different approach to arrive at the same conclusion. Thanks to the experimental design of the program (see Meyer 1995; Angrist and Pischke 2009 for literature review on natural experiments), this paper uses graphical comparisons and simple statistical tests, rather than assuming and estimating the consumers' utility function with an exhaustive list of variables - a challenging task in choice modeling as pioneered by McFadden (1972).

This paper is organized as follows. Section 1 puts the program in the context of a natural experiment. Section 2 introduces the data and their descriptive analysis. Section 3 discusses the results from formal statistical tests. Section 4 summarizes the paper's findings.